The economy and red metals markets are in a strengthening, but still tenuous, position, reported two economic experts who addressed copper producers and distributors at the Copper and Brass Servicenter Association’s annual meeting March 30 in Bonita Springs, Fla.

No End in Sight to Copper’s Volatility

“The commodity markets have evolved beyond simple supply and demand. You really have to look at other variables as you make purchasing and selling decisions,” said Ed Meir, economist with Madison Holdings Group in New York.

Copper prices have experienced big swings in the past year, from a low under $1.50 per pound to a high over $3.50. Prices rose despite excess stock levels on the London Metal Exchange. “Rising stocks and rising prices have led to a lot of head-scratching. Prices should not rise as inventories rise,” he noted.

One big reason is speculation by investors. “Commodities are being bid up as inflation hedges. It’s easy to buy commodity proxies, which did not exist 10 or 15 years ago,” Meir said. Alternative investments such as hedge funds, commodity trading advisor funds and index funds represent only about 2 percent of global investments, so there is much room to grow, he added. “Fund money is not going away. If anything it means more volatility for us.”

Economic recovery will affect demand for copper products, but not rapidly. Meir predicts the U.S. is likely to experience a slow, gradual U-shaped recovery. “The drivers are all missing for faster growth,” he said.

With interest rates already near zero, there is little more stimulative effect to be had from monetary policy. High unemployment continues to dampen consumer spending, which is 75 percent of GDP. Financial institutions continue to struggle in the aftermath of the housing bust. And the tech boom that created millions of jobs in the decade of the Nineties is behind us. “Here we are in 2010 with interest rates at zero, the technology sector has matured, the banking sector is on its back and manufacturing is struggling. I look down the road and I just don’t see what will kick start things,” Meir said.

In contrast to some other experts, Meir does not believe China will take the lead in global economic recovery. Unlike the consumer-driven economy in the United States, much of China’s growth is export driven, and its current boom is heavily reliant on spending by a government that is retrenching to slow its overheated economy. “I don’t think the Chinese on their own will be able to drive commodity prices worldwide. Their economy is not big enough to replace us. They need 8 percent growth to break even, like we need about 3 percent growth.”

As China’s growth slows, its imports of copper products will decline, which could affect global pricing. China imported 3.2 million tons of copper last year, double the two previous years, which suggests that some may have been stockpiled rather than consumed. If that’s the case, Chinese imports in 2010 could drop even more sharply.

Nevertheless, questions about China and a slow-growth recovery in the United States do not necessarily mean copper prices will trend downward in the next year, Meir said. Copper stocks are at relatively low levels coming out of the recession, so demand may pressure supply, and investors will continue to put money into commodities.

With caveats about all the factors that make copper prices so unpredictable, Meir forecasts that copper will average $3.22 per pound in 2010, rising to $3.31 in 2011. “I’m not as bullish as the crowd. I think the market is way overdone, and the Chinese will not be as big a factor. We are somewhat cautious going forward,” he said.

Economy Calls for Caution

Housing is at the heart of the nation’s economic problems, said economist William Conerly of Conerly Consulting, Lake Oswego, Ore.

The vacancy rate is too high for both owned and rental properties. When politicians pass policies to keep people in their homes, or to get more people to buy houses, they worsen the problem in the rental sector. “A person buying a house is not coming from a cardboard box. He is coming from a rental unit. You can push the peas around on the plate, but you can’t solve the whole problem by focusing on foreclosures and new mortgages,” Conerly said.

The ultimate solution to the housing problem is demographics. “If we are going to deal with our supply of excess housing, we simply need more people. Our population grows at about 1 percent per year. In a year’s time, we would solve the problem, except that on top of the housing crisis we have a recession,” he said.

Economic conditions are so bad that people are divorcing yet continuing to live in the same house. Their grown children are coming back home because they cannot find a job. Even immigrant workers are returning to their home countries because there is no work for them here. These and other factors will continue to dampen demand for housing until the economy rebounds, he said. “There is no quick fix. It will take time. No politician is going to jumpstart the housing industry.”

Sky-high unemployment continues to weigh heavily on consumer spending. Even consumers with job security are frightened. Many have cut back on spending and increased their savings, which is a positive for the long-term and will eventually lead to increased consumption, Conerly said. But in the meantime, this attitude hampers economic growth.

“Consumers are going to be a driving force going forward—but not a booming force,” Conerly said. “Normally consumers show some exuberance coming out of a recession. I don’t expect it this time.”

There is still much benefit to come from government stimulus programs, he continued, as much of the money is yet to be spent. Monetary policy has a lagging effect averaging 12 months. “Fourth-quarter GDP was over 5 percent, so it is working, and it will continue to work as some stimulus is still in the pipeline.”

Inflation is a real risk of government monetary policy. There’s usually a 24-month lag before prices start to escalate, which means the Fed should start pushing up both short- and long-term interest rates this year to head off inflation in 2011 or 2012. “If we are going to take action to prevent inflation, we need to do that before we can see the whites of its eyes,” Conerly said,

Some people believe that because of political pressure to keep the economy stimulated, the government won’t act on interest rates quickly enough. Eventually, the Fed will have to hit the brakes hard, which could push the country into another recession in 2012 or 2013. “I really think there is a risk of the Fed mismanaging this,” Conerly said. “I recommend you do economic contingency planning for another downturn.”

Pointing to future challenges for business, Conerly noted that as the economy improves, service centers’ working capital needs will expand as they need to replenish their depleted inventories. “Are you ready if sales increase? Do you have the cash flow to buy more raw materials and pay more workers?” he asked.

Indeed, will materials be readily available from vendors that have shut down equipment and laid off employees? It will take them time to ramp up, too. Thus inventory planning is critical. “Customers will do business with the companies that have inventory. You need to have material, otherwise they will just go elsewhere,” he said.